Ch. 31: Mergers

Question 1

What are the three types of mergers?

Answer 1

Horizontal mergers
Vertical mergers
Conglomerates mergers

Question 2

A merger taking place between two firms in the same line of business: competing companies is a ____

Answer 2

Horizontal merger

Question 3

A merger involving companies at different stages of production i.e. the buyer expands back toward the source of raw materials or forward in the direction of the ultimate consumer is a _____

Answer 3

Vertical merger

Question 4

A merger involving companies in unrelated lines of business, and one that has no effect on the operations or profitability of either firm is a ___

Answer 4

Conglomerate merger

Question 5

In a merger, the prevalent possible source of added value is termed ____

Answer 5

Synergies

Question 6

It is often easier to predict synergies than it is to realize them

True/ False

Answer 6

True

Question 7

One of the sensible motives for mergers is synergies leading to economies of scale. Which of the following is NOT a source of economies of scale?
A) cost savings through e.g., shut-down of less efficient departments and lower labor costs
B) industry consolidation and higher market power
C) larger bargaining power
D) sharing of central services

Answer 7

B) industry consolidation and higher market power

This is another sensible motive for mergers, but not economies of scale

Question 8

Vertical integration facilitates co-ordination and administration  When two parts of an operation are highly dependent on each other, it often makes sense to combine them into a vertically integrated firm.

This “sensible” motive for merger is termed ____

Answer 8

Economies of vertical integration

Question 9

Firms with a surplus of cash and a shortage of good investment opportunities often turn to mergers financed by cash as a way of redeploying their capital. I.e., this is a case of surplus funds.

Is this a sensible or dubious motive for merger?

Answer 9

Sensible

Question 10

Which of the following is NOT a sensible motive for merger?
A) Economies of scale
B) Economies of vertical integration
C) Complementary resources
D) Surplus funds
E) Elimination of inefficiencies
F) Diversification
G) industry consolidation

Answer 10

F) Diversification

This is classified as a dubious motive

Question 11

Why is diversification a dubious reason for merger?

Answer 11

Merging for the sake of diversification is not a good motive, since diversification is easier and cheaper for the stockholder themselves than for the corporation –> stockholders are not willing to pay a premium for diversified firms; in fact, discounts are more common.

Question 12

Which of the following statements are not true for the bootstrap effect
A) mergers with the goal of achieving the bootstrap effect is categorized as dubious
B) the effect relates to when a merger happens through stock acquisition leading to a higher EPS without any real gain created by the merger
C) the bootstrap game generates earnings growth, not from capital investments or improved profitability, but simply from purchase shares of slowly growing firms with low P/E ratios
D) leads to lower financing costs

Answer 12

D) leads to lower financing costs

Question 13

Why is lower financing costs obtained from a merger categorized as a dubious motive for merger? One of the following options are wrong
A) lower financing costs is difficult to realize in practice from a merger
B) shareholders gain from a lower interest rate by guaranteeing the other entity’s debt, giving bondholders better protection. Therefore, there is no net gain
C) lower financing costs never leads to a net gain

Answer 13

Wrong: C) lower financing costs never leads to a net gain

Merging decreases the probability of financial distress, which can increase borrowing capacity. The corresponding higher value from interest tax shields CAN lead to a net gain from the merger

Question 14

The market’s presence or absence of anticipation of the merger can have a significant impact on the price that the acquirer ends up paying for the target

True/ False

Answer 14

True

Question 15

If the acquirer is optimistic and believes that the share price of the combined entity will be higher than initially anticipated, the preferred payment method is:

A) stock
B) cash

Answer 15

B) cash
if acquirer management is optimistic, and believes that the share price of the merged entity will be higher than initially anticipated – because corresponding gain in a market correction will fall entirely on A’ stockholders

Question 16

If acquirer is pessimistic and believes that the share price of the merged entity will be lower than initially anticipated, the preferred payment method is:

A) stock
B) cash

Answer 16

A) stock
because corresponding loss in a market correction will fall partly on B’s stockholders, where if payment was with cash, the entire loss would fall on stock A shareholders

Question 17

The Antitrust law generally states that acquisitions are forbidden whenever the effect “may be substantially to lessen competition, or to tend to create a monopoly.”

True/ False

Answer 17

True

Question 18

What are the three forms of acquisition?

Answer 18

1) merge two companies into one
2) buy the seller’s stocks in exchange for cash, shares or other securities
3) buys some or all of the seller’s assets

Question 19

When a company assumes all assets and all liabilities of the target firm, such an acquisition must be approved by a least 50% of the stockholders of each firm.

Which form of acquisition is this?

Answer 19

Merging two companies into one

Question 20

Ownership of the assets is transferred, and payment is made to the selling firm rather than directly to its stockholders.

Which form of acquisition is this?

Answer 20

Buying the seller’s assets

Question 21

In the acquisition form: buying the seller’s stocks, which of the following statements is not true?
A) stocks of the target is bought in exchange for cash, shares, or other securities
B) the buyer can deal individually with the shareholders of the selling company
C) the seller’s management must approve the acquisition

Answer 21

Wrong: C

The seller’s management may not be involved at all - even thought the approval and cooperation is sought, the acquisition can be complete without. In this case, the buyer can attempt to acquire an effective majority of the outstanding shares, and if successful, gain control and complete the acquisition

Question 22

The purchase price in excess of the target’s book value are to be assigned/ reported on the asset side of the balance sheet as _____

Answer 22

Goodwill

Question 23

Which of the following statements is not true about goodwill?
A) the acquiring firm is obliged to estimate the fair value of goodwill every year
B) if the estimated goodwill value falls below the book value reported goodwill value on the B/S, it is “impaired”
C) goodwill impairment means that the balance sheet value of goodwill must be adjusted upwards
D) the write-off in the case of goodwill impairment must be deducted from the year’s earnings on the P&L statement

Answer 23

Wrong:
C) goodwill impairment means that the balance sheet value of goodwill must be adjusted DOWNWARDS

Impairment means that some goodwill value on B/S is to be written off and deducted from that year’s earnings

Question 24

Tax considerations in an acquisition:

If an acquisition payment is in the form of cash, it is regarded as:
A) tax deductible
B) taxable

Answer 24

B) taxable

In this case, the selling shareholders are treated as having sold their shares, and must pay tax on any capital gains

Question 25

In a taxable acquisition, the assets of the selling firm are revalued, with the resulting write-up or write-down being treated as a taxable gain or loss, and tax depreciation is recalculated on the basis of the restated asset values.

True/ False

Answer 25

True

Question 26

If the acquisition payment is largely in the form of shares, the acquisition is:
A) tax-free
B) taxable

Answer 26

A) tax-free

The shareholders are viewed as exchanging their old shares for similar new ones - no capital gains or losses are recognized

Question 27

After a tax-free (stock-based) acquisition, the merged firm is taxed as if the two firms had always been together

True/ False

Answer 27

True

Question 28

If a country does not have a territorial tax system, meaning that profits earned overseas are also taxed at the home country’s rate, which incentive implications doe this have on domestic firms?

A) it creates an incentive for foreign firms to change their domicile to the country, since it streamlines the tax management of the company

B) it creates an incentive for the firm to change its domicile to a country with lower tax rate through merger (being acquired by foreign-established firm)

Answer 28

B) it creates an incentive for the firm to change its domicile to a country with lower tax rate through merger (being acquired by foreign-established firm)

Question 29

Following statement applies to the market for corporate control (select all correct):

A) it is a mechanism by which firms are matched up with owners and management teams who can make the most of the firm’s resources
B) if it is possible for the value of the firm to be enhanced by changing management or by reorganizing under new owners, there will be incentives for someone to make the change

Answer 29

Both are true

Question 30

Which are the three ways to change the management of a firm?
A) a leveraged buyout
B) selling crown jewels
C) a takeover through tender offer
D) a successful proxy contest

Answer 30

A) a leveraged buyout
C) a takeover through tender offer
D) a successful proxy contest

Question 31

Which of the following statements is/ are not true about a proxy contest?
A) a group of shareholders votes in a new board who then pick a new management team
B) a proxy is the right to vote another shareholder’s shares
C) in a proxy contest, the dissident shareholders attempt to obtain enough proxies to elect their own slate o the BoD
D) a proxy fight is a direct contest for control of the firm
E) proxy contests are very often successful

Answer 31

Wrong: E) proxy contests are very often successful

A proxy contest is very expensive and difficult to win. Dissidents who engage in proxy fights must use their own money, but management can use the corporation’s funds and lines of communications with shareholders to defend itself

Question 32

In a ____, the would-be acquirer offer to buy shares directly to the shareholders of the target. If successful, the new owner is free to make any management changes.

This is one of the 3 ways to change the management of a firm called what?

A) leveraged buyout
B) proxy contest
C) Takeover through tender offer

Answer 32

C) Takeover through tender offer

Question 33

One of the ways in which the incumbent board/ management can defend hostile takeovers is putting in place a poison pill. What does this entail?

Answer 33

if any single shareholder acquired a holding of more than x% of the firm’s stock, the poison pill will allow the firm to offer its other shareholders additional shares at a substantial discount, thus diluting the ownership of a potential acquirer.

Question 34

Shark-repellent is a mechanism for takeover defense. Which of the following is/are not shark-repellents?
A) staggered (classified) board
B) supermajority
C) fair price
D) poison pill
E) restricted voting rights
F) waiting period

Answer 34

D) poison pill

Question 35

When the board is classified into three equal groups, where only one group is elected each year, resulting in the hostile acquirer not being able to gain control immediately.

Which type of shark-repellent is a mechanism for takeover defense is this?

A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period

Answer 35

A) staggered (classified) board

Question 36

When a high percentage of shares, typically 80%, is needed to approve a merger, which type of shark-repellent mechanism for takeover defense is this?

A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period

Answer 36

B) supermajority

Question 37

When mergers are restricted unless a fair price (determined by formula or appraisal) is paid, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period

Answer 37

C) fair price

Question 38

When shareholders who acquire more than a specified proportion of the target have no voting rights unless approved by the target’s board, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period

Answer 38

D) restricted voting rights

Question 39

When unwelcome acquires must wait for a specified number of years before they can complete a merger, which type of shark-repellent mechanism for takeover defense is this?

A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period

Answer 39

E) waiting period

Question 40

When existing shareholders are issued rights that, if there is a significant purchase of shares by a bidder, can be used to purchase additional stock in the company at bargain price, this is:

A) poison put
B) poison pill

Answer 40

B) Poison pill

Question 41

When existing bondholders can demand repayment if there is a change of control as a result of a hostile takeover, what type of pre-offer defense is this?

Answer 41

Poison put

Question 42

Which of the following is NOT a post-offer defense mechanism?
A) Litigation
B) Liability restructuring
C) Asset restructuring
D) Poison put

Answer 42

D) Poison put

Question 43

When target files a suit against bidder for violating antitrust or securities laws, which type of post-offer defense mechanism is this?

Answer 43

Litigation

Question 44

When a target buys assets that the bidder does not want, or that will create antitrust problems, this is a post-offer defense mechanism termed _____

Answer 44

Asset restructuring

Question 45

When a target issues shares to a friendly third party, increasing the number of shareholders, or repurchases shares from existing shareholders at a premium - this dilutes the shares of the hostile acquirer.

Which type of post-offer defense mechanism is this?

Answer 45

Liability restructuring

Question 46

In an attempt to overcome target managers’ opposition to takeovers, the acquirer can offer golden parachutes. What does this mean?

Answer 46

Golden parachute: a generous payoff if the managers lose their jobs as a result of a takeover

Question 47

A merger adds value only if the two companies are worth more together than apart

True/ False

Answer 47

True

Question 48

Buyer Firms Typically gain more from a Merger than Seller (Target) Firms

True/ False

Answer 48

False: targets tend to gain and buyers tend to roughly break-even

Question 49

Why do sellers generally gain more from mergers than buyers? (Select all correct)

A) buyer is typically larger, and sometimes, even substantial net benefits do not show up clearly in the buyer’s share price
B) competition among potential bidders can force up the takeover premium, and more of the merger gain slides toward the target
C) behavioral explanations: the managers of acquirer may be driven overconfidence in their ability to run target better than existing management - and therefore pays too much because gains are overestimated
E) the threat of takeover may spur managers of the targe to work harder, leading to better performance

Answer 49

All are true

Question 50

There are occasions when the merger does achieve gains but the buyer nevertheless loses because it pays too much

True/ False

Answer 50

True

Example: target inventory value may be overestimated; cost of renovation and integration may be underestimated; target may have environmental liabilities such as pollution giving rise to unexpected clean-up costs

This is why due diligence is particularly important

Question 51

Corporate diversification does not increase value in perfect markets as long as investors’ diversification opportunities are unrestricted. This is the explanation of which principle?

Answer 51

Value-additivity principle

Question 52

In a conglomerate merger, there is no possibility of excess demand of the merged stock, but a definite possibility of excess supply. This means that the stock price of the combined entity will be less or equal to the price of the two entities separate:

PV_AB ≤ PV_A + PV_B

True/ False

Answer 52

True
Conglomerate mergers are not in coherence with the value additivity principle